China warns US debt idea is 'playing with fire'

Beijing, June 8, 2011

US Republican lawmakers are "playing with fire" by contemplating even a brief debt default as a means to force deeper government spending cuts, an adviser to China's central bank said on Wednesday.

The idea of a technical default -- essentially delaying interest payments for a few days -- has gained backing from a growing number of mainstream Republicans who see it as a price worth paying if it forces the White House to slash spending, Reuters reported on Tuesday.

But any form of default could destabilise the global economy and sour already tense relations with big US creditors such as China, government officials and investors warn.

Li Daokui, an adviser to the People's Bank of China, said a default could undermine the US dollar, and Beijing needed to dissuade Washington from pursuing this course of action.

"I think there is a risk that the US debt default may happen," Li told reporters on the sidelines of a forum in Beijing. "The result will be very serious and I really hope that they would stop playing with fire."

China is the largest foreign creditor to the United States, holding more than $1 trillion in Treasury debt as of March, US data shows, so its concerns carry considerable weight in Washington.

"I really worry about the risks of a US debt default, which I think may lead to a decline in the dollar's value," Li said.

The US Congress has balked at increasing a statutory limit on government spending as lawmakers argue over how to curb a deficit which is projected to reach $1.4 trillion this fiscal year. The US Treasury Department has said it will run out of borrowing room by August 2.

If the United States cannot make interest payments on its debt, the Obama administration has warned of "catastrophic" consequences that could push the still-fragile economy back into recession.

"It has dire implications for the economy at a time when the macro data is softening," said Ben Westmore, a commodities economist at National Australia Bank.

"It's just a horrible idea," he said. Financial markets are following the US debate but see little risk of a default.

US Treasury prices were firm in Europe on Wednesday, supported by a flight to their perceived safety on the back of the Greek debt crisis and worries about a slowdown in US economic growth.

Marc Ostwald, a strategist with Monument Securities in London, said markets were working on the assumption that the US debt story "will go away". But nervousness would grow if a resolution was not reached in the next five to six weeks.The Republicans' theory is that bondholders would accept a brief delay in interest payments if it meant Washington finally addressed its long-term fiscal problems, putting the country in a stronger position to meet its debt obligations later on.

But interviews with government officials and investors show they consider a default such a grim -- and remote -- possibility that it was nearly impossible to imagine.

"How can the US be allowed to default?" said an official at India's central bank. "We don't think this is a possibility because this could then create huge panic globally." - Reuters